HRA Tax Implications: All You Need To Know

As a senior consultant with a multi-national company, Rajesh earns a pay package of Rs 12 lakh per annum. And it's that time of the year again where he’s looking for different ways to save on tax. His net taxable salary, after deductions, is approximately Rs 6.70 lakh p.a., i.e. after exhausting the Rs 1.50 lakh limit available under Section 80C.

As there’s an investment declaration to be filed with the HR department of the organisation, he perceives there is no other way to save more tax. As a result, his current direct tax outgo works out to Rs 64,746.

Like Rajesh, are you unable to explore options beyond Section 80C?

Then read on ...

There are other ways to reduce your taxable income.

Now, the income declaration form covers only certain sections of the Income-tax Act, 1961.

However, it is not the only route to save tax. It would be prudent to avail the benefits of the other Sections as well. And makes it important to first optimally restructure your salary!

But, before we explain how to restructure your salary to save on tax, let's first look at Rajesh's current salary structure to understand how the components influence the taxable income.

Rajesh's employer offers him allowances such as: house rent allowance, leave travel allowance, conveyance allowance, and medical reimbursements. The total exemption limit available under these headings works out to Rs 3.58 lakh.

However, he can claim only Rs 2.38, lakh. This, along with the investments of Rs 1.50 lakh under Section 80C, reduces his net taxable income to Rs 8.09 lakh. On this income, he has to pay tax of Rs 89,466 or Rs 7,455 per month. Take a look at the HRA calculation presented in the table below:

Salary Components

In Rs

Gross Salary

1,200,000

Salary Structure

Basic Pay

600,000

EPF Contribution @12%

72,000

House Rent Allowance

300,000

Leave Travel Allowance

24,000

Conveyance Allowance

19,200

Medical Reimbursement

15,000

Other Allowance

169,800

Exemptions Allowed

House Rent Allowance (Section 10 (13A))

180,000

Leave Travel Allowance (Section 10 (5))

24,000

Conveyance Allowance (Section 10(14))

19,200

Medical Reimbursement (Section 17(2))

15,000

Total Exemptions under Section 10 & 17

238,200

Profession Tax

2,500

Income chargeable under the head Salary

959,300

Deductions under sec 80C

150,000

Net taxable income*

809,300

As per the current tax slabs:

Tax Slabs

Tax rate

Applicable Amount

Balance

Tax

0- 250000

0%

250,000

559,300

-

250001 - 500000

10%

250,000

309,300

25,000

500001 - 1000000

20%

309,300

-

61,860

> 1000000

30%

-

-

Tax on Income

86,860

Education Cess @3% on Income tax payable

2,606

Total Tax Liability

89,466

Tax per Month

7,455

Note: *Assuming income from salary is the only source of income

Rajesh can’t avail complete exemption for the allowances because the different components in his salary were non-optimally structured. Let us first understand the concept of Basic Salary and House Rent Allowance (HRA) as main components of the salary structure.

Basic Salary

The basic pay forms the base component for other benefits such as Provident Fund, House Rent Allowance (HRA), etc. While a higher basic means higher benefits, on the flip side, it is fully taxable. This is because the basic salary constitutes 30% – 40% of your Cost-to-Company (CTC).

So, having a very high basic component may lead to having a high tax liability in absolute Indian rupee terms. On the other hand, if you reduce your basic salary considerably, you would lose out on the other benefits such as Leave Travel Allowance (LTA), House Rent Allowance (HRA), and superannuation benefits associated with your basic.

Therefore, it is important to have an ‘optimal’ basic salary. A very high basic salary may result in a higher tax outgo. Therefore, you need to maintain the right balance.

House Rent Allowance (HRA)

HRA stands for House Rent Allowance.

It is taxable under the IT Act subject to specified exemption limits.
If you do one of the following then your HRA is fully taxable, not exempt if you:

reside in your own house; or

do not pay rent for house occupied by you.

However, if you are living in a rented house and you are the one paying the rent, then HRA exemption can be availed for the period during which you occupy the rented house during the relevant tax year.

Also, to claim the exemption, your employer is required to obtain appropriate and adequate proof of payment of rent for the entire period for which you want to claim exemption.

An exception to the 'proof required' HRA rule is that, if you are a salaried employee drawing HRA up to Rs. 3,000 per month, you do not have to provide a rent receipt to your employer.

The maximum amount that can be claimed as an exemption under HRA is the least of –

Actual HRA; or

Rent paid in excess of 10% of basic salary + Dearness Allowance (DA) if in terms of service; or

50% of basic salary + DA in case of Chennai, Delhi, Kolkata, Mumbai
or
40% of salary + DA in case of other cities

Therefore, for Rajesh to claim full HRA of Rs 3.00 lakh, he needs to pay a minimum rent of Rs 30,000 p.m. or Rs 3.6 lakh p.a. (Total rent paid: Rs 3.6 lakh; 10% of basic: Rs 60,000; Rent paid in excess of basic=Rs 3.6 lakh-Rs60,000 = Rs3 lakh). If Rajesh stayed in a self-occupied house, he is not entitled to any HRA exemption and the entire HRA amount is taxable. However, if he had taken a loan to own this property, he could have claimed tax deductions on the home loan.

Unfortunately, Rajesh pays Rs 20,000 p.m. as rent and though he is eligible for HRA, he is unable to claim the full amount. Therefore, it would make sense for Rohan to reduce his basic and HRA.

We will further look at how Rajesh can re-structure his salary to bring down his tax outgo. But first, let's dig in deeper to understand the concept and dos and don'ts while claiming for HRA exemption.

What are the documents required to claim HRA?

To obtain HRA exemption, you are required to submit appropriate and adequate proof of payment of rent for the entire period for which you want to claim exemption.

Second, if you are paying an annual rent of more than Rs 1 Lakh (i.e. Rs 8,333 per month), report the Permanent Account Number (PAN) of your landlord to the employer (Earlier you had to furnish a copy of the PAN card of your landlord only if your annual rent exceeded Rs 1.80 lakh, or Rs 15,000 per month).

And if your landlord does not have a PAN, you need to file a declaration to this effect from your landlord along with the name and address of the landlord.

But as an employee, if your salary has an HRA of less than Rs 3,000 per month, you are not required to provide a rent receipt to your employer.

Now if you are not living in a rented accommodation, you still have few options to claim HRA exemption. Some common questions asked for HRA exemption are as follows:

1. Can I Pay rent to my parents/ spouse and claim for HRA exemption?

Though there is a rise in the nuclear family system in India and the demographics are changing along with an increase in disposable income, many still live with parents.

Hence, you can pay rent to your parents and claim for HRA exemption if they own that house. Please note: In this case, they have to claim that rental income from house property.

But, you cannot pay rent to your spouse and claim for HRA exemption if you own that house. And if you live in a house owned by your spouse, you can claim for HRA exemption.

2. Can I claim HRA if I pay rent to my relative?

If you are living in a rented apartment owned by a relative, it is always better to enter into an agreement. And make sure that you pay rent by cheque or electronic transfer. If paying by cash, ensure that your cash transaction is traceable. Mere rent receipts won’t suffice to claim deductions.

In order, to maintain healthy relations, it is recommended to keep your money and legal relations crystal clear, so that there is no awkward situation in future. By doing so you can eliminate the potential for relationships to turn sour.

3. Can I claim both HRA and take home loan deduction benefit to save tax?

Yes, as far as the IT Act is concerned – the two sections on HRA and Rental Income are completely separate, so you can avail HRA exemption and also home loan tax benefits.

For example:

Suppose you are renting a house close to where you work, but your home is elsewhere, and you are repaying a home loan on your home property. In this case you can avail your HRA deduction, as well as take the tax benefit of the home loan. The two sections (dealing with HRA and Home Loan benefit) are completely separate in the IT Act.

Also remember, if you are renting out the property on which you have taken the home loan and are receiving rental income, your rental income is taxable, after the standard deduction of 30%.

4. Can I claim HRA if I live in a house that I own?

No, you cannot claim for HRA deduction against the house you own, because logically you do not pay rent to yourself for living in that house.

5. Can I claim HRA if I'm not currently paying any rent?

No, you can claim for HRA deductions only if you have a proof for the expense incurred. In other words, you need to have electronic/ traceable proof of the amount equal to the rent paid.

If you claim rent allowance while paying rent to your relatives/ family members it is better to fulfil below conditions:

Enter into an agreement such as leave and license agreement

You must incur the expense of rent and preferably pay via bank transfers or cheque

If rent is paid in cash, then it should be traceable – via bank withdrawals

The said rent paid must be reasonable as per the ongoing rent in the locality

Additionally, disclosure of rental income by the recipient is recommended to avoid scrutiny

Let’s look at how Rajesh can re-structure his salary and optimise his basic pay.

First, he needs to reduce the basic pay to Rs 4.8 lakh. Thus, his HRA will fall to Rs 2.4 lakh and can be claimed to the full extent. The only concern is that his contribution to EPF will fall as well, reducing the amount eligible under Section 80C. However, he's not worried because he contributes Rs1 lakh to tax-saving equity mutual funds.

Rajesh’s employer can include other allowances in his salary structure, through which he can claim other exemptions. By doing this, he can claim an additional of Rs 36,000 as exempt income through meal vouchers and other allowances. With a higher amount claimed under HRA, his total taxable income falls by as much as Rs 56,000.

Thus, Rajesh's tax outgo will be reduced by nearly Rs 12,000 to Rs 77,930 or Rs 6,494 p.m. A lower PF contribution, thanks to a lower basic pay, can take his net salary up by Rs 35,536 p.a. Take a look at the table below…

HRA calculation as per the old and new salary structure:

Tax Computation

Current (Rs)

Restructured (Rs)

Gross Salary

1,200,000

1,200,000

Salary Structure

Basic Pay

600,000

400,000

EPF Contribution @12%

72,000

48,000

House Rent Allowance

300,000

200,000

Leave Travel Allowance

24,000

24,000

Conveyance Allowance

19,200

19,200

Medical Reimbursement

15,000

15,000

Other Allowance

169,800

493,800

Exemptions Allowed

House Rent Allowance (Section 10 (13A))

180,000

200,000

Leave Travel Allowance (Section 10(5))

24,000

24,000

Conveyance Allowance (Section10(14))

19,200

19,200

Medical Reimbursement (Section 17(2))

15,000

15,000

Other exempt allowance

36,000

Total Exemptions under Section 10 & 17

238,200

294,200

Profession Tax

2,500

2,500

Income chargeable under head 'Salary'

959,300

903,300

Deductions under sec 80C

-150,000

-150,000

Net taxable income*

809,300

753,300

Tax on Income

86,860

75,660

Education Cess @3% on Income tax payable

2,606

2,270

Total Tax Liability

89,466

77,930

Tax per Month

7,455

6,494

Note: *Assuming income from salary is the only source of income

So, Rajesh can effectively reduce his taxable income just by restructuring his salary.

But this restructuring is specific to his profile. You need to restructure your salary to suit your needs and expenses. For example, if your job requires you to travel a lot, you can ask them to include a higher conveyance allowance. Some of the most common allowances are Leave Travel Allowance (LTA), Transport Allowance and Medical Allowance.

Leave Travel Allowance (LTA)

As a salaried individual, you can claim LTA for any journey made either alone or with dependent family members in India. The maximum amount you can claim is the least of:

The amount actually incurred; or

The amount of LTA allowed

The exemption is extended for two journeys performed in a block of four calendar years. The current block is 2014-2017. The exempted amount is restricted only to expenses incurred on travelling to the destination. It does not include expenses such as hotel bills, food, etc.

Transport allowance

Expenses incurred to commute between your home and work place is also exempt from tax. The maximum amount that is exempt is Rs 1,600 per month.

Medical reimbursement

Expenses incurred by you or your family for medical purposes can also help in reducing the tax liability. A maximum of Rs 15,000 can be claimed every financial year for medical expenses. But to claim this, you are required to submit, to your employer, the medical bills for the financial year stating the total amount you intend to claim.

To Conclude

Hence, you can claim tax exemption of upto 100% of the actual HRA received. But make sure you always have correct documents in place. Enter into a lease and license agreement (LL) with your parents to build your case stronger.

Please note while claiming for tax deduction, you or spouse, or minor child, or as a member of the Hindu Undivided Family (HUF) must not own any house property. And if you own any residential property at any place and earn rent from it, no deduction is allowed.

However, you can simultaneously claim deductions for a home loan against interest paid and principal re-payment along HRA; in case you have rented out the house or you live in another city.

Re-structure your salary if needed and maximise your tax savings.

Last minute tax planning can lead to lower savings and inefficient investments. PersonalFN is of the view that you need to plan your taxes at the start of the year, to see where you stand and make adjustments accordingly. It is important for you to know the various routes to save tax on your income the legal way.

To start with, download our free tax planning guide here. You can save and use this for future reference. It can also help you cross-check if you are on the right track towards saving on taxes and to take timely action, in case you have missed any benefits.

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